Delaware's Top Five Worst Shareholder Decisions for 2012 (#3: Central Laborers Pension Fund v. News Corp.)
Shareholders in Delaware often see their suit dismissed at the demand excusal stage of litigation. This occurs before discovery has taken place. Moreover, this is the case despite the fact that the information needed by shareholders to surmount the relevant pleading barriers is often not in the public domain. Director independence is an example.
Rather than adopt a more reasonable standard at the pleading stage, the Delaware courts have all but required shareholders to first seek to inspect documents under Section 220. On the one hand, making an inspection request mandatory adds cost and delay to derivative suits. This will likely result in fewer suits. On the other hand, the approach may cause shareholders to uncover documents that strengthen the suit.
These requests will often confront opposition from the company. The courts have provided considerable latitude to resist. The statute requires that shareholders have a proper purpose, something the Delaware courts have narrowly construed. The courts have also required that shareholders provide a "credible basis" for any purpose alleged in the inspection request. Thus, shareholders asserting that the compensation paid to executive was excessive was not enough to gain access to the necessary documents since the claims were not accompanied by a "credible basis" that the compensation decisions violated the board's fiduciary obligations.
In Central Laborers Pension Fund v. News Corp., a case discussed here, represents a new approach in the battle over inspection rights and an illustration of the willingness of the courts to impose limits on shareholders seeking to invoke inspection rights. The Plaintiff submitted a request for documents. After receiving no response within the five days specified in the statute, Plaintiff filed an action to compel under Section 220. Plaintiff also filed a derivative suit.
The Chancery Court dismissed the action under Section 220, concluding that “once the derivative action is filed, and until the judicial processing of the dismissal motion reaches the point where a recasting of the allegations has been authorized, the stockholder may not, as a general matter, demonstrate a proper purpose for invoking Section 220.” In other words, the actual purpose was irrelevant. The fact of filing a derivative suit somehow negated the presence of a proper purpose.
On appeal, the Supreme Court affirmed, but on different grounds. Thus, the Court did not specifically disavow the interpretation, leaving lower courts free to use it again. Instead, the Court opted to affirm on the basis of an argument made at, but not considered by, the Chancery Court.
It turns out that Plaintiff had inadvertently failed to submit an attachment to its affidavit demonstrating beneficial ownership at the time of the inspection request. See Id. ("Apparently, Central Laborers was unaware of that omission in its Inspection Demand until News Corp. briefed its motion to dismiss in the Court of Chancery."). Upon learning of the oversight, Plaintiff provided the requisite document. Id. ("along with its answering brief on News Corp.’s motion to dismiss in the Court of Chancery, Central Laborers filed a revised Koeppel Affidavit and the missing documentary evidence of its beneficial stock ownership.").
The Court nonetheless concluded that the failure to include the attachment with the request violated the terms of the statute. In effect, this failure rendered the request invalid ab initio and obviated any obligation on the part of the company to response. See Id. ("Absent such procedural compliance, the stockholder has not properly invoked the statutory right to seek inspection, and consequently, the corporation has no obligation to respond.").
Thus, the language in the statute that gives shareholders the right to bring an action absent a response from the company within five business days (action can be filed if "the corporation, or an officer or agent thereof, refuses to permit an inspection sought by a stockholder or attorney . . . or does not reply to the demand within 5 business days after the demand has been made") doesn't apply in the case of a clerical error in the original request. Only plaintiffs will not know, until after the law suit is filed, whether the lack of a response is a denial of the right to inspect or the lack of obligation to respond because of a clerical error. As a result, shareholders that make "clerical errors" in submitting inspection requests may only learn of this months later after incurring expenses associated with litigation.
Oddly, the Court actually described this as an approach that "recognizes the importance of striking an appropriate balance between the rights of stockholders and corporations." It doe no such thing. Other limitations (credible basis for example) are ostensibly designed to prevent fishing expeditions. Allowing clerical errors to be invoked only after litigation had been lodged and motions filed does little more than provide an additional strategy in defeating inspection requests.
Primary materials on this case are posted on the DU Corporate Governance web site.